A column on personal finance prepared by the Virginia Society of Certified
Public Accountants

INDEPENDENT CONTRACTOR OR EMPLOYEE? HOW TO TELL THE DIFFERENCE

March 18, 2004) – Classifying workers appropriately is an important
risk management activity for any business. The Virginia Society of CPAs points
out that employers who misclassify employees as independent contractors may
find themselves liable for back payments of employment taxes in addition to
stiff penalties and interest payments. In some cases, an employer could be
required to provide retroactive benefits, such as vacation pay and retirement
plan contributions, to a misclassified worker.

An IRS investigation of a firm’s worker classifications can result from
either a random audit of the firm or from a triggering event. For example,
a worker applying for unemployment benefits or filing a Worker Compensation
claim could challenge his or her classification. To protect your business,
it’s important to understand how the IRS classifies employees and independent
consultants.

Level of Control Is a Key Factor

There is no single, clear-cut test for classifying workers as independent
contractors or employees. However, level of control is a key factor.
According to the
IRS, a worker is an employee if the company he or she works for has the
right to control when, where, and how to do the assigned task.

Independent contractors are not “controlled” by the companies
that hire them. Although the firm decides what needs to be done and the due
date, it is up to the independent contractor to decide the means by which the
job is accomplished. Contractors typically work for a number of different companies
and may hire others to work on the assignment. Employees, on the other hand,
usually work for one employer and have set hours of work.

The 20-Factor Test

While the most important factor is control, the IRS uses a list of 20 factors
to determine a worker’s status. According to this list, the following
are characteristics of independent contractors: setting their own work hours;
furnishing their own tools; not receiving training from the hiring firm;
working for more than one firm at a time; being paid by the job rather than
by the hour; not providing progress reports; making their services available
to the general public; and paying for their own business and travel expenses.
No single factor is determinative. They can carry different weights, and
the IRS applies them on a case-by-case basis. For more information, refer
to IRS Publication 15-A, Employer's Supplemental Tax Guide. It is available
through the IRS Web site at www.irs.gov.

Safe Harbor Rule Offers Some Protection

There is an IRS Section 530 “safe harbor” rule that exempts some
workers from the 20-factor test. To qualify, the hiring company must meet all
three of the following requirements: (1) the company has a reasonable basis
for classifying the workers as independent contractors; (2) the company has
consistently treated these and all similar workers as independent contractors
in the past; and (3) the company has consistently filed Form 1099-MISC information
returns for these and all similar workers.

Seeking Expert Advice Is Critical

If after reviewing the 20 factors, you’re still not sure whether the
person you are hiring should be classified as an employee or an independent
contractor, you can complete Form SS-8, Determination of Employee Work Status
for Purposes of Federal Employment Tax and Income Tax Withholding. After reviewing
your situation, the IRS will make the determination for you.

You also may consult with a CPA who can provide valued insights on the complexities
of classifying workers.

The Virginia Society of CPAs is the leading professional association
dedicated to enhancing the success of all CPAs and their profession by communicating
information and vision, promoting professionalism, and advocating members’
interests. Founded in 1909, the Society has nearly 8,000 members who work
in public accounting, industry, government and education. This Money Management
column and other financial news articles can be found in the Press Room on
the VSCPA Web site at www.vscpa.com.